February was a particularly difficult month for the global equity markets, which saw a correction of 8,5% over the period as a result of the coronavirus epidemic. This may be qualified as a high-intensity reaction: the markets are fearing the potential consequences of a situation in which global supply chains are being pressurised, international trade is slowing down and tourism is under quarantine. A situation like this is likely to deal a blow to business and household confidence.
The OECD’s baseline economic scenario expects the epidemic to peak in the first quarter with a “moderate” number of cases outside China, the epicentre of the virus. Global growth is expected to fall to 2,4% for 2020 as a result, down 0,5 percentage points from 2019. China is also expected to see growth fall to 4,9%, 1,2 percentage points lower than last year. We are also urging vigilance in respect of economies that are strongly interconnected with China, such as Japan, South Korea and Australia.
With uncertainty at its peak, the markets were expecting a rapid response from policymakers to support the economy. Against this background, the US Federal Reserve (Fed) made an urgent rate reduction of 50 basis points, with rates moving into the 1-1,25% range, reflecting the desire to restore confidence in the short term in both the markets and the real economy.
In our opinion, the response should not be just monetary, because fiscal support for the economies is imminent. Hong Kong set an example by granting an exceptional distribution of the equivalent of EUR 1.200 to every adult citizen to support consumption. In Europe, the Italian government also plans to spend more by applying the clauses of the Stability and Growth Pact intended to limit Member States’ spending. This will enable it to spend more without breaching European budgetary rules.
Budgetary and monetary policies may therefore have very little positive impact on the hit taken by the production chain.
It should be emphasised, however, that the measures adopted are primarily demand-side policies that could instil a sense of optimism in the short term. To expand on this: a demand-side policy can offset a weakness in consumption or investment by increasing public spending or reducing key interest rates in order to avoid too strong a slowdown in the economy.
With this epidemic, though, we are facing a negative supply shock, meaning that companies’ production capacity is affected. Budgetary and monetary policies may therefore have very little positive impact on the hit taken by the production chain.
In this period of unpredictability, we are maintaining a neutral positioning on equities by favouring defensive sectors such as Health Care, Real Estate and Communication Services.
February saw a growing number of Coronavirus outbreaks around the world. The risks inherent in this situation overshadow investors’ optimism and dragged the financial markets downwards. Performance calculated in euros was negative at the end of February: the MSCI World, the international equity market index, lost -7,54%, while its European and US counterparts fell by -6,21% and -8,35%, respectively. This context of correction has caused performance calculated in euros over 2020 to fall into negative territory.
In fact, investors fear that the virus will spread in such a way that governments will be forced to impose drastic quarantine measures (for example, the Italian government has quarantined 11 cities in the north of the country), and companies will be forced to shut down their operations (as Apple and Adidas have done in China). Initial comments and earnings of companies show that the proliferation of the coronavirus does not bode well for upcoming earnings reports. For example, according to brewer AB Inbev, Covid-19 is expected to have a negative impact on its first-quarter income of USD 285 million. Similarly, Booking.com, the online hotel booking platform, expects a fall in bookings of -5% to -10% in the first quarter of 2020.
From a geographical perspective, we still have a slight preference for the US market over the European market. With that in mind, we are taking advantage of the access to secular growth stocks, which are more numerous in the United States than in Europe. Moreover, the safe haven nature of the US dollar provides additional protection in the event of a downturn in financial markets. It should also be noted that the Fed has more leeway than the European Central Bank (ECB) to stimulate the economy and support the markets.
In terms of our sector recommendations, we still favour Communication Services, Real Estate, and Health Care. Overall, these sectors offer better growth profiles, benefit from lower rates and trade at reasonable valuations. They are also less susceptible to the spread of the coronavirus than other sectors. In addition, we have revised our exposure to the Utilities sector to neutral due to a growth profile that is much greater than average (US earnings rose 21,6% versus only +0,9% for S&P 500 stocks). In addition, the sector benefits from a low risk profile due to its regulated activities and domestic exposure. Finally, the fall in rates is restoring the reputation of dividend yields and making the sector attractive to investors looking for yields.
Sovereign yields and bonds
Coronavirus remained the burning issue in February. The increase in the number of cases and the number of countries reporting new cases led to a fall in sovereign rates, which are deemed to be safe havens. In parallel, inflation expectations were being lowered in the US, and the Fed was quick to surprise markets by cutting its key rates. The 10-year US Treasury yield is below the critical threshold of 1,00%, while the 10-year German Bund is below -0,60%.
In Europe, the ECB was initially less concerned: in its view, the situation did not require any readjustment to its monetary policy and there was therefore no need to overreact. One week later, however, the tone changed, with the institution stating that it was ready to act if necessary, as it now shared the same concerns as investors, who were fleeing to safety by continuing to favour the purchase of AAA-AA sovereign bonds over Italian, Spanish and Portuguese treasury bills. With an entirely negative German yield curve, it is currently difficult for us to give a recommendation to buy these securities.
On the other hand, for investors with a stronger risk profile, Italian government bonds with maturities of between 3 and 30 years are still displaying good rates and may represent an opportunity for investors seeking both liquid and yield-generating bonds.
In terms of money market investments, given the downward trend and historically low rates in Europe, investing in a money market instrument denominated in euros is not an attractive option for investors.
The credit market was not immune to the upheaval generated by the spread of coronavirus, with the rapid fall in investor risk appetite having a dramatic effect on private debt risk premiums, both in the US and Europe. However, this widening of risk premiums is also the consequence of the flight to safety, which is benefiting sovereign debt and widening the gap between the two asset classes. Logically, the stocks most affected were those most exposed to China and those with a geographically extensive supply chain.
Yields remain at very pedestrian levels, however, mainly due to the support of central banks. In Europe, the ECB asset purchase programme continues to support demand. In the US, the anticipation of further rate cuts in order to provide assistance to an economy that is likely to catch a cold is having a positive effect on all debt.
With this in mind, we have no particular concerns about private debt. Even though the forecasts of the most cyclical companies have been revised downwards, the asset class continues to be attractive in terms of yield, especially since US sovereign rates have fallen below 1%.
We are maintaining a positive bias for debt issued by defensive—and therefore non-cyclical—companies that are demonstrating observable financial prudence in managing their balance sheets. The overall responsiveness of central banks gives us confidence in our preference for securities eligible to be purchased by the ECB, as the institution could intensify its asset purchase programme.
Between the 1st and 19th of February, the dollar continued the positive trajectory that began in January, maintaining its gains against the euro. At the start of February, it was priced at 1,10, falling to 1,0794 on 19 February. At the end of the month, the price was back to its 1st of February level.
The strengthening in the dollar seen in the first 20 days of the month was consistent with the flight to safety that began in January. These movements were mainly due to growing geopolitical tensions and the rapid spread of coronavirus.
Additionally, the subsequent strengthening of the euro can also be explained by market expectations of rate cuts by the Fed. These expectations were confirmed by the Fed’s 50bp emergency cut on the 3rd of March. As a result, the differential between US and European rates has become relatively more favourable to the euro, which has emerged stronger.
In addition, with ECB rates in the red, it is difficult to foresee the possibility of aggressive rate cuts within the eurozone, in contrast to the action the Fed is likely to take in the US.
Given the volatility levels, we are remaining within the range of 1,08-1,13 reported in previous editions.
Volatility in the financial markets and the search for safety helped gold to briefly break through the USD 1.650/ounce barrier, posting gains of almost 4% since the beginning of the year (it closed at USD 1.585/ounce on 28 February). Stocks in gold producers suffered, however, in February, as investors facing margin calls on their accounts threw in the towel by beginning to take profits.
Should the correction in the equity markets continue, it will probably push investors towards safe haven investments, with increasingly negative interest rates reducing the opportunity cost of holding an asset, like gold, that does not pay dividends or coupons. We are therefore continuing to favour exposure to changes in the price of gold through shares in mining companies, due to the significant operational leverage they offer. Furthermore, this is exactly the situation that their latest earnings reports describe: generated liquid funds and dividends are both increasing. Debt is falling and capital expenditure appears to be under control.
We expect the price of gold to remain stable above USD 1.600 per ounce, with real upside potential if the stock markets continue to be turbulent or if the number of coronavirus-related infections increases dramatically.
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This document was produced by the Private Banking Unit and BCEE Asset Man-agement. The drafting of this document was completed on 5 March 2020 at 5:00 pm..
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